Airline Industry Will Have To Maintain Capacity Discipline To Remain Profitable

Last year, the U.S. airline industry posted its fourth consecutive profitable year. This is in sharp contrast to the decade prior to these years, when the industry was posting huge losses. Till as late as 2008, U.S. airlines were struggling to post operating profits. In 2008 alone, U.S. airlines posted operating losses of $5.6 billion. That however improved to operating profits of over $5 billion in 2012 and the profits in 2013 were even higher. [1] In 2014, airlines are on track to continue growing their profits. So, what apart from the economic recovery from the financial crisis of 2008-09, has enabled this turnaround in the airline industry’s financial health? We figure the strict capacity discipline followed over the last few years by network airlines such as Delta (NYSE:DAL), United (NYSE:UAL) and American (NASDAQ:AAL) has enabled this turnaround. Looking ahead, we figure for the industry to remain profitable, it is essential that it maintains this capacity discipline.

Capacity Discipline Has Played A Key Role In Helping Extract The Airline Industry From Losses

During the financial crisis of 2008-09, airlines slashed their flying capacities substantially in response to the sudden decline in demand for air travel. This is evident from the Bureau of Transportation Statistics data which shows that available seat miles, a measure of flying capacity, in the domestic U.S. air travel market fell from 744 billion miles in 2007 to 667 billion miles in 2009. [2] In the following years, even as the demand environment improved, network airlines did not add significant capacity. Delta Airlines for instance, raised its capacity by only 1% during 2009-2013. [3] [4] United lowered its flying capacity from 253 billion miles in 2011 to 245 billion miles in 2013. [5] American also did not add significant flying capacity to its network during this period. As these large airlines maintained steady flying capacity even as demand for air travel rose driven by economic recovery, overall industry air fares increased. This is also highlighted by data from the Bureau of Transportation Statistics which shows that average round-trip air fares in current dollars increased by 17% during 2007-2013. [6] These higher air fares were instrumental in lifting the airline industry out of its losses. The capacity discipline was so retained that even today the overall flying capacity in the domestic U.S. air travel market is below its pre-recession level. The total available seat miles in the domestic air travel market were 693 billion miles in 2013, down from 744 billion miles in 2007. [2]

Prior to the financial crisis, airlines were adding capacity to their networks more freely in an attempt to grow their market shares. As a result, the supply of seats was exceeding the demand for flights, which was undermining the ability of airlines to charge profitable fares. As airlines persisted with this strategy, they continued to post losses. The economic crisis forced airlines to adjust their capacities in line with demand. This time, airlines’ did not race to add capacity as the economic recovery began. So, over the past few years, as demand for flights improved, fares rose as airlines held back on capacity expansion. It is important to note that the consolidation in the airline industry also made it easier for the remaining airlines to hold back on capacity expansion.

Delta & United Have Said That They Will Add Capacity With Restraint

Looking ahead, it is absolutely crucial for airlines to maintain this capacity discipline if they want to retain their profitability. Many airlines have indicated that they will add flying capacity, but with discipline. Delta and United recently said they will add flying capacity to their networks at a rate of around 2% per year. But both also added, that their capacity expansion will not outpace growth in demand for flights. In our view, this mindful approach to capacity addition will make the airline industry’s profits sustainable over the long term. We also figure that this disciplined capacity addition is maintainable for the foreseeable future as airlines have found another area of growth in ancillary heads including extra baggage and ticket change fee, fee for access to on-board WiFi and other entertainment options, and revenues from sale of in-flight food and drinks. A recent report from the Government Accountability Office (GAO) mentioned that baggage and ticket change fee collected by U.S. airlines increased from about $1.4 billion in 2007 to $6 billion in 2012. [1] Airlines are continuing to grow their portfolio of ancillary heads which will likely help them maintain their restrained capacity growth stance. If however, airlines begin to add capacities at rates that exceed demand growth, then profits could decline. But its not a scenario taking place presently.

Comments

Per our discussion on the airlines. I have been watching but not gotten into it. Short term gains would have been great but I don't know the business well enough yet. Here is an article on seat miles and restaint combined with the lower jet fuel. You could monitor the prices of all but would have to do it frequently. They also pay very low dividends. Still during your unemployment the short term gains might be worth your time, along with the futures price of jet fuel. There was an article in yesterday's paper in Motley's Fool about how stock brokers are mostly salespeople not investors, and you are better off to watch your own money....for all investors.

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